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The Bahamas Investor25This short list is certainly notexhaustive. Furthermore, these aspectsare of prime interest when analyzingcurrent divergences in economic growthand wealth. The ability of a society to increaseproductivity relies on a number ofinterdependent factors. Among them isan efficient incentive structure by theestablishment of property rights, a fullyfunctioning credit channel includingappropriately regulated financial marketsand the availability of credit. Furthermore,research and development and, even moreimportantly, innovation play a central rolein achieving higher productivity.Property rights essentialProperty rights are an essential part oflending agreements. If a borrower isrequired to back a loan with his or herown property, a major incentive iscreated to use the borrowed capitalefficiently. As in the worst caseborrowers can lose everything, and theyare strongly encouraged to work moreor become more productive in order toavoid a default. Borrowing without theguarantee of private property, hencewithout any real incentive to serviceand/or repay debt, severely limits thepositive impact that the availability ofcredit can have on economic growth. The rise in public debt may also havean adverse impact on the incentivesgoverning the relationship betweenborrowers and lenders. This can beillustrated by the structural break in thepositive correlation between debt andwealth in the US.As public debt is generally notguaranteed by private property, theincentive structure is partly invalidated.The fact that in the US privatemortgages tend to be guaranteed onlyby the house itself additionally weakensthe incentive structure of credit. This isin contrast to the situation in othercountries, where private households canbe obliged to use all of their assets toguarantee a loan. In those emergingeconomies where property rights areinadequately protected by the legalsystem, or where property is at risk dueto political factors (corruption or otheroperational shortcomings), incentives tohonour credit obligations in full mayalso be lacking, although significantprogress has been made in this regardover the past decade.Economic policy can stimulate andcontrol debt-based growth not only byshaping incentive structures throughlegal frameworks, but also byappropriately regulating financialmarkets. However, the sheer complexityof contemporary financial markets doesnot make their regulation easy. Thesearch of financial institutions for newareas of revenue has pushed financialinnovations closer to the limits ofregulation and comprehension. In someexamples, economic policy makers wereunaware of the risks of certain financialproducts while embracing them ascatalysts for debt-based economic120% of GDPEvolution of government debt1101009080706050403019701975Advanced economiesSource: IMF, Julius BaerEmerging marketsWorld19801985199019952000200520102015The importance of credit to enhance growth is undisputed and the accessibility to capital markets is decisive in developing the capital base.INVESTING

26The Bahamas Investorgrowth. Indeed, the liberalization offinancial markets boosted theaccessibility to credit of all kinds ofquality and transparency, like highlycomplex products such as collateralizeddebt obligations (CDOs). Following the recent global financialcrisis, a prime example for theconsequences of adverse incentivestructures combined with complexfinancial innovations, we need toconsider the prospects for credit-basedgrowth over the next decade. In theaftermath of the financial crisis, the biasfor financial market regulation hasshifted towards tightening.Furthermore, in particular manydeveloped economies have accumulatedexcessive debt levels-both private andpublic-which suggests a high need fordeleveraging going forward.Various empirical studies show thatafter periods of large debtaccumulation-and correspondinglyhigh growth levels due to debt-basedgrowth-economies enter into cycles of"creditless (growth) recoveries." It canbe argued that following the last debt-spurred growth cycle, culminating inthe financial crisis, developed marketsare facing a prolonged period of lesscredit-driven (ie creditless) and hencesub-par economic growth, which is adirect consequence of deleveragingefforts and stricter financial regulation. Nevertheless, the importance of creditto enhance growth is undisputed and theaccessibility to capital markets is decisivein developing the capital base. Acomparison between economies showsthat emerging markets still have thepotential to enhance their accessibility tofinancial markets. Ironically, among thedeveloped markets it is the debt-troubled European economies that areincreasingly lacking access due to theirworsened credit ratings, whereas amongemerging markets, Southeast Asian andLatin American debt policies are lookingoptimistic with regard to credit access.Access to capitalFor the citizens of many developing andemerging economies, however, access tocapital is not as easy as in developedeconomies. Less developed economiesoften lack even the simple preconditionsfor a lending environment, such as basicmeans of communication ortransportation. It is therefore notsurprising that these economies haveimmense difficulty in generating afunctioning and growing localentrepreneurship. In this regard, thereare some promising approaches to startenabling access to capital for the localpopulation, such as microfinance. Microfinance aims at closingthe gap by providing financialservices to low or minimal-income clients in developingcountries. Generally these clientsare people who cannot providecollateral for a loan and/or suffer from illiteracy. Such access to financing is a huge advantagefor both the individual and theeconomies concerned. It can spur thedevelopment of small businesses andself-employment and thus boostinvestment, as well as consumption.With a larger proportion of societygaining access to financial services, youwould expect to see positive effects onoverall economic growth. Many examples for this developmentcan be found in Latin America, Africaand Asia. Furthermore, efficienttelecommunications networks, enablinglarge population groups to communicatecheaply and quickly by mobile phone,facilitate exchanges between thesuppliers and consumers of goods andfinancial services better than ever beforein the history of the emerging marketsconcerned. This is a rather new factorenhancing economic growth potential,which is important especially foremerging markets, as the construction ofmobile phone networks is cheaper thana costly fixed-wire infrastructure.New growth patternCertain excesses regarding the creditchannel of growth, such as the neglect ofproper financial market regulation, willbe a headwind for economic growth inthe developed economies concerned.This clearly strengthens the superioroutlook of several emerging marketswith powerful workforce dynamics: anumber of emerging market economieswith currently high birth rates and largeproportions of very young population,such as the Asian economies India,Indonesia, Malaysia or Vietnam andSouth American economies such asBrazil, will be able to rely on verypositive demographic trends goingforward. In contrast, western European,North American and Australasianeconomies, but also developed Asianeconomies such as Japan, are expected tosuffer from a distinct decline in theworking-age population as a share of thetotal population, while their workingpopulation is already relatively smallcompared to the global average. Demographics will thus become amajor differentiating factor for thegrowth pattern in the next decade. Onthe other hand, knowledge, respectivelyknowledge management, as well ascredible property rights will become theother key differentiating drivers.Several emerging market economies,which lack knowledge and innovativecapacities, have been gaining know-howthrough transfer from developedeconomies. As a result, many Asianeconomies, which gladly opened theproduction plants for developedmarkets, now boast companies thatproduce complex high-tech goods.Hence, for many emerging marketcountries it has become crucial toestablish conditions that attract foreigninvestment and encourage the transferof know-how to their economies. However, there are limits to this know-how transfer as the stock of borrowableideas is running lower. If emergingeconomies grow richer by relying.a number of emergingeconomies will leave thesheltered environment ofcatch-up growth and willface tougher challenges.INVESTING